Where's the Peak?

I've been going through the International Energy Agency's new forecast for medium-term oil and natural gas markets, issued yesterday. In contrast to the IEA's warnings of last summer concerning an imminent oil supply crunch, the agency now sees ample supplies to accommodate the level of demand growth it anticipates for the next five years. Yet while this scenario does not envision a peak in global oil supplies before 2015, its components offer ample cause for concern about the growing market power of OPEC and the risk of geopolitical disruptions. It also signals the growing importance of non-traditional sources of liquid fuels, including natural gas liquids (NGLs) and biofuels, which are included in the IEA's oil supply & demand balance.

The headline features of the IEA's oil forecast include continued growth in global oil capacity from 91 million barrels per day (MBD) in 2009 to 96.5 MBD in 2015. This is driven by the growth of OPEC's capacity, the NGL output of a global natural gas expansion that the US shale gas boom has accelerated, and increased production of ethanol and other biofuels. IEA sees this combination as more than sufficient to counteract a roughly 3.5% annual decline in the output of existing oil fields, including a peak and net decline in non-OPEC production within the next year or two. The latter won't surprise anyone who's been following the Peak Oil issue, but it's all the more worrying when you consider that it doesn't include the impact of project delays owing to the on-again, off-again US deepwater drilling moratorium, which the administration seems determined to switch back on.

This picture is fraught with risks and vulnerabilities, including the prominent role of Iraqi oil revitalization projects, which appear to account for half of the growth in OPEC crude oil capacity in the period. Although there's ample scope to stimulate more output from Iraq's mature fields, and the potential of its undeveloped fields represents the largest conventional oil opportunity in the world, none of it will come to fruition if the county doesn't remain quasi-stable. This might be one area in which the reassignment of General Petraeus to Afghanistan from his CentCom post, where he retained oversight of the Iraq security situation, might not look so positive.

Then there's that shift toward NGLs and biofuels, including the IEA's somewhat surprising prediction that while biofuels will continue to grow globally, the rate of growth will slow, with US output reaching a plateau long before it has attained the targets of the Renewable Fuels Standard. They also appear to be even more skeptical than I am that cellulosic ethanol is on the verge of scaling up rapidly. The larger problem is that both of these sources constitute what I would call "hamburger helper" for oil. Neither ethanol nor first-generation biodiesel (FAME) constitutes an effective gallon-for-gallon substitute for petroleum products, except in blends limited by both infrastructure and legacy vehicle fleets not equipped to handle more than small percentages of these fuels. NGLs provide propane and butane essentially indistinguishable from crude-sourced LPG and just as useful for petrochemicals and heating fuel, but they yield much less in the way of gasoline components, and the ones they do require significant processing to boost their octane, now that tetra-ethyl lead is out of the picture.

On the demand side, things look pretty much as we'd expect in the aftermath of a global recession that hit the developed world harder than the big developing countries--BICs, if not BRICs. As was true before the financial crisis, however, the Middle East contributes the second-biggest source of new demand, after Asia. That means continued growth in domestic demand within some of today's largest oil exporters. Even if that doesn't lead to "peak exports", it buttresses the fundamental shift in global market power underpinning a forecast that might otherwise appear calming to markets.

Anyone looking to the IEA for signs of an imminent peak in global oil supplies won't find it in their Medium Term Oil and Gas Markets 2010 report. What I see instead is a continuation of the world we are already in, with OPEC holding the trump cards. Traders tend to focus on the weekly fluctuations of oil market inventories and indications that supply or demand may grow or shrink in the months and years ahead. Yet while the release of this report, together with another build in US crude inventories this week, reportedly contributed to the $2/bbl drop in oil prices in the last two days, these reactions seem oblivious to a larger reality. With more than 5 million barrels per day of OPEC production capacity shut in, the main reason that oil is trading in the mid-to-high $70s, rather than the mid-to-high $40s, is that OPEC is functioning as a truly effective cartel that is much happier with higher prices. Politicians looking for another economic stimulus might consider the anti-stimulus that oil prices are currently providing, and the consequences of policies that could hand even more power to OPEC in the short-to-midterm.